Chapter 19 A Preview
of Macroeconomics 508
Economic Output over Time 509
Economic Growth: The Relentless Uphill Climb 509
The Economic Growth Record / The Economic Growth
Slowdown
Economic Fluctuations: Temporary Setbacks and
Recoveries 511
A Recession's Aftermath / Recessions versus
Depressions
Jobs, Inflation, and Interest Rates 515
Employment, Productivity, and Unemployment 515
The Record on Jobs and Productivity / Unemployment
During Recessions
Inflation 519
Interest Rates 520
Different Types of Interest Rates and Their
Behavior / The Concept of the Real Interest Rate
Macroeconomic Theory and Policy 522
Economic Growth Theory and Economic Fluctuation Theory
522
Aggregate Supply and Long-Term Economic Growth 522
The Production Function
Government Policy for Long-Term Economic Growth 524
Fiscal Policy / Monetary Policy
Economic Fluctuations Theory and Policy 525
Aggregate Demand and Economic Fluctuations /
Macroeconomic Policy for Economic Fluctuations
Conclusion 526
Key Points 528 / Key Terms 528 / Questions for
Review 528 / Problems 528
Using Economics to Explain a Recession's Pain
Around the Country 518
Appendix to Chapter 19 The Miracle of Compound
Growth 531
Chapter 20
Measuring the Macroeconomy 532
Measuring GDP 533
A Precise Definition of GDP 533
Prices Determine the Importance of Goods and
Services in GDP / Intermediate Goods Are Part of Final
Goods / Three Ways to Measure GDP
The Spending Approach 535
Consumption / Investment / Government Purchases /
Net Exports / A Key Equation
The Income Approach 539
Labor Income / Capital Income / Depreciation /
Indirect Business Taxes / Net Income of Foreigners /
National Income and Personal Income
The Production Approach 541
Saving, Investment, and Net Exports 544
The Definition of the Country's Saving 544
Saving Equals Investment plus Net Exports 544
Saving by the Young, the Middle-Aged, and the Old /
Government Saving / People Saving and Investing
Real GDP and Nominal GDP 547
Adjusting GDP for Inflation 547
Computing Real GDP Growth Between Two Years / A
Year-to-Year Chain / From the 1992 Base Year to Other
Years / Real GDP versus Nominal GDP over Time
The GDP Deflator 549
Other Inflation Measures 552
Shortcomings of the GDP Measure 553
Revisions in GDP 554
Omissions from GDP 554
Home Work and Production / Leisure Activity / The
Underground Economy / Improved Products
Other Measures of Well-Being 555
Vital Statistics on the Quality of Life /
Environmental Quality
International Comparisons of GDP 556
The Problem with Using Market Exchange Rates for
Comparisons 557
Purchasing Power Parity Exchange Rates 557
Reversals of International Rankings
Conclusion 558
Key Points 559 / Key Terms 559 / Questions for
Review 559 / Problems 560
Stocks and Flows 537
Reading the News About GDP Each Month
550
Part 5 Long-Run
Fundamentals and Economic Growth 562
Chapter 21
Unemployment and Employment 564
Employment and Unemployment Trends 565
Cyclical, Frictional, and Structural Unemployment 565
How Is Unemployment Measured? 566
Who Is Employed and Who Is Unemployed? / The Labor
Force and Discouraged Workers / Part-Time Work
Comparing Three Key Indicators 569
Aggregate Hours of Labor Input 570
Effects of Unemployment on Labor Input / Case
Study: CEA Forecasts of Future Aggregate Hours
The Nature of Unemployment 572
Reasons People Are Unemployed 572
Job Losers / Job Leavers / New Entrants and
Re-entrants
Long-Term versus Short-Term Unemployment 575
Unemployment for Different Groups 577
Determination of Employment and Unemployment
578
Labor Demand and Labor Supply 578
Case Study: Explaining Long-Term Unemployment Trends
579
Why Is the Unemployment Rate Always Greater than Zero?
580
Job Rationing / Job Search
Policy Implications 582
The Effects of Taxes / Policies to Reduce the
Natural Unemployment Rate
Conclusion 586
Key Points 586 / Key Terms 586 / Questions for
Review 587 / Problems 587
Reading the News About Employment Each Month
576
Reading the News About European Unemployment 584
Chapter 22
Investment in New Capital 590
Investment and the Accumulation of Productive
Capital 591
Gross Investment, Net Investment, and Increases in
Capital 591
Government Investment 593
Public Infrastructure Investment / Using Investment
(I) in Practice
Investment As a Share of GDP 594
The Investment Share versus the Other Shares of GDP
594
If One Share Goes Up, Another Must Go Down 595
Interest Rates and Consumption, Investment, and Net
Exports 596
Consumption 596
Consumption and the Interest Rate / Movements along
versus Shifts of the Consumption Share Line
Investment 598
Net Exports 599
The Interest Rate and the Exchange Rate / The
Exchange Rate and Net Exports / Combining the Two
Relationships
Putting the Three Shares Together 601
Determining the Equilibrium Interest Rate 602
Adding the Nongovernment Shares Graphically 602
The Share of GDP Available for Nongovernment Use 602
Finding the Equilibrium Interest Rate Graphically 603
Analogy with Supply and Demand / The Real Interest
Rate in the Long Run
Impacts on the Investment Share 605
A Change in Government Purchases 605
Impact on Investment of a Shift in Consumption 606
The Saving Investment Approach 608
The National Saving Rate and the Interest Rate 609
Determination of the Equilibrium Interest Rate 609
Effect of a Downward Shift in the National Saving Rate
610
Determination of Government's Share of GDP 611
Arguments over the Appropriate Size of Government 611
Size of Government and Economic Growth 612
Conclusion 612
Key Points 613 / Key Terms 613 / Questions for
Review 613 / Problems 614
Interest Rates and Exchange Rates 600
Anticipation of Changes in Government Purchases
608
Chapter 23
Technology and Economic Growth 616
How Economics Got the Nickname the "Dismal Science"
617
Labor Alone 618
Diminishing Returns to Labor / Malthusian
Predictions
Labor and Capital Only 623
Output Can Rise above Subsistence / Diminishing
Returns to Capital
Labor, Capital, and Technology 627
What Is Technology? 627
Invention, Innovation, and Diffusion / Organization
and Specialization / Human Capital
The Production of Technology: The Invention Factory
629
Special Features of the Technology Market 630
Growth Accounting 632
The Growth Accounting Formula 632
Case Studies: Using the Growth Accounting Formula 634
Productivity Slowdown in the United States / Demise
of the Soviet Union / A Tale of Two Countries
Technology Policy 636
Policy to Encourage Investment in Human Capital 636
Policy to Encourage Research and Innovation 636
Technology Embodied in New Capital 637
Is Government Intervention Appropriate? 637
Conclusion: Implications for Potential GDP 638
Key Points 639 / Key Terms 639 / Questions for
Review 639 / Problems 640
Thomas Robert Malthus, 1766-1834 622
A Graphical Illustration of Growth Accounting
633
Appendix to Chapter 23 Deriving the Growth
Accounting Formula 641
Key Points 642 / Key Term and Definition 642 /
Questions for Review 643 / Problems 643
Chapter 24 The
Monetary System and Inflation 644
What Is Money? 645
Commodity Money 645
Three Functions of Money 645
Medium of Exchange / Store of Value / Unit of
Account
From Coins to Paper Money to Deposits 646
Alternative Definitions of the Money Supply 647
The Fed and the Banks: Creators of Money 648
The Fed 649
Board of Governors / The District Federal Reserve
Banks / The Federal Open Market Committee (FOMC)
The Balance Sheet of a Commercial Bank 651
The Role of Banks in Creating Money 652
Bank-by-Bank Deposit Expansion / A Formula Linking
Reserves and Deposits
How the Fed Controls Money Supply: Currency Plus
Deposits 655
The Money Supply (M) and Bank Reserves (BR)
656
Currency versus Deposits 656
The Money Multiplier 657
Money Growth and Inflation 659
The Quantity Equation of Money 659
Some Key Episodes in Monetary History 660
Inflation: Effects on Unemployment and Productivity
Growth 663
Effects on Unemployment 663
Effects on Productivity Growth 664
Why Is Inflation Almost Always Greater than Zero? 665
Printing Money to Finance Government Expenditures /
Bias in Measuring Inflation / Concerns about Deflation or
Disinflation
Conclusion 666
Key Points 667 / Key Terms 667 / Questions for
Review 667 / Problems 668
Part 6 Economic
Fluctuations 670
Chapter 25 The
First Steps Toward Recession or Boom 672
Changes in Aggregate Demand First Lead to Changes
in Output 673
Production and Demand at Individual Firms 675
Normal Capacity Utilization and the Natural
Unemployment Rate / Production and Employment Decisions
at Actual Firms
Why Changes in Demand Are Translated into Changes in
Production 676
Limited Information and Implicit Contracts / A
Graphical Illustration of the Typical Firm
Could Economic Fluctuations Also Be Due to Changes in
Potential GDP? 678
Forecasting Real GDP 679
A Forecast for Next Year 679
A Conditional Forecast 681
The Response of Consumption to Income 682
The Consumption Function 682
The Marginal Propensity to Consume /Which Measure
of Income?
What About Interest Rates and Other Influences on
Consumption? 684
Finding Real GDP When Consumption and Income Move
Together 685
The Logic of the Two-Way Link Between Consumption and
Income 685
The 45-Degree Line 686
The Aggregate Expenditure Line 686
The Slope of the AE Line / Shifts in the AE
Line
Determining Real GDP Through Spending Balance 689
A Better Forecast of Real GDP 690
Spending Balance and Departures of Real GDP from
Potential GDP 693
Stepping Away from Potential GDP 693
Starting Away from Potential GDP 694
Conclusion 694
Key Points 695 / Key Terms 695 / Questions for
Review 695 / Problems 696
The Forecasting Industry 680
Forecasting with Econometric Models 692
Chapter 26 The
Uncertain Multiplier 698
How to Find the Multiplier 699
A Graphical Derivation of the Multiplier 699
The Multiplier for a General Shift in the Aggregate
Expenditure Line / Specific Cases of the Multiplier
An Algebraic Derivation of the Multiplier 701
Following the Multiplier Through the Economy 704
The Size of the Multiplier 707
The Multiplier and the Slope of the AE line 707
The Multiplier and the Marginal Propensity to Consume
708
Uncertainty about the Size of the Multiplier 710
A Key International Issue: Net Exports Depend on
Income 710
How Do Net Exports Depend on Income? 710
Exports / Imports / Net Exports
The AE Line When Net Exports Depend on Income
712
Effects on the Size of Multiplier 713
How the Multiplier Depends on the MPI and the MPC /
The Rounds of the Multiplier When Net Exports Depend on
Income
The Impact on the Trade Deficit 716
Does Investment Depend on Income Too? 717
The Multiplier for a Tax Change 717
The Forward-Looking Consumption Model 719
Consumption Smoothing 720
The MPC for Permanent versus Temporary Changes in
Income 720
Tests and Applications of the Forward-Looking Model
721
Permanent versus Temporary Tax Cuts / Anticipating
Future Tax Cuts or Increases
Conclusion 723
Key Points 723 / Key Terms 723 / Questions for
Review 724 / Problems 724
The Origins of the Multiplier 705
John Maynard Keynes, 1883-1946 709
Chapter 27
Aggregate Demand and Price Adjustment 726
The Aggregate Demand/Inflation Curve 728
Interest Rates and Real GDP 728
Investment / Net Exports / Consumption / Spending
Balance
Interest Rates and Inflation 732
Central Bank Interest Rate Policy / A Graph of the
Response of the Interest Rate to Inflation / A
Simplifying Assumption
Derivation of the Aggregate Demand/Inflation Curve 735
Movements along the Aggregate Demand/Inflation
Curve / Shifts of the Aggregate Demand/Inflation Curve /
Government Purchases / Changes in the Target Inflation
Rate / Other Changes
The Price Adjustment Line 739
The Price Adjustment Line Is Flat 739
Expectations of Steady Inflation / Staggered Price
and Wage Setting
The Price Adjustment Line Shifts Gradually When Real
GDP Departs from Potential GDP 741
Changes in Expectations or Commodity Prices Shift the
Price Adjustment Line 742
Does the Price Adjustment Line Fit the Facts? 742
Combining the Aggregate Demand/Inflation Curve and
the Price Adjustment Line 744
Conclusion 745
Key Points 745 / Key Terms 746 / Questions for
Review 746 / Problems 746
Reading the News About the Fed 734
Chapter 28 Toward
Recovery and Expansion 748
The End of Recessions and Booms 749
Real GDP and Inflation over Time 749
A More Detailed Report: Economic Behavior Behind the
Scenes 751
Short Run / Medium Run / Long Run
The Return to Potential GDP after a Boom 754
Changes in Monetary Policy 755
The Volcker Disinflation 757
Reinflation 759
The Case of a Price Shock or Supply Shock 759
What Is a Price Shock? 760
The Effect of Price Shocks 760
Temporary Shifts in the Price Adjustment Line /
Stagflation
Combining Different Scenarios 762
A Monetary Policy Change with a Government Purchases
Change 762
Monetary Errors and Reversals: A Boom-Bust Cycle 763
Conclusion 765
Key Points 767 / Key Terms 767 / Questions for
Review 767 / Problems 768
Using Economics to Explain the Recovery from the
Great Depression 758
Brief History of Thought on Price Adjustment 764
Part 7
Macroeconomic Policy 770
Chapter 29 Fiscal
Policy and the Budget Deficit 772
The Government Budget: Taxes, Spending, the
Deficit, and the Debt 773
Setting the Annual Budget 773
A Balanced Budget versus a Deficit or Surplus / The
Proposed Budget versus the Actual Budget
A Look at the Federal Budget 776
The Deficit / Taxes and Spending / The U.S. Budget
Deficit versus Other Countries
The Federal Debt 777
Long-Term and Short-Term Debt / The Debt to GDP
Ratio
State and Local Government Budgets 779
Discretionary and Automatic Countercyclical Fiscal
Policy 780
Impacts of the Instruments of Fiscal Policy 780
Changes in Government Purchases / Changes in
Taxes
Countercyclical Fiscal Policy 783
Discretionary Changes in the Instruments of Fiscal
Policy / Automatic Changes in the Instruments of Fiscal
Policy
The Discretion versus Rules Debate for Fiscal Policy
786
Economic Impact of the Budget Deficit 787
Short-Run and Long-Run Impact of the Deficit 787
Ricardian Equivalence / The Burden of the Debt /
Overall Assessment
Credible Deficit Reduction Plans 788
Interest Rates and Expectations
The Structural versus the Cyclical Deficit 792
Budget Reforms 794
Conclusion 795
Key Points 795 / Key Terms 796 / Questions for
Review 796 / Problems 796
Using Economics to Explain a Rise in Long-Term
Interest Rates 790
Chapter 30 Monetary
Policy 798
Central Bank Independence 799
Short-Run Gains versus Long-Run Pain 799
The Political Business Cycle 801
Time Inconsistency 801
Government Borrowing from the Central Bank 801
Possible Abuses of Independence 802
Money Demand, Money Supply, and the Interest Rate
803
Money Demand 803
Money Supply 804
The Determination of the Interest Rate 805
Fed Policy Actions 806
Open Market Operations and Changes in the Federal
Funds Rate 806
The Monetary Transmission Channel 808
Other Tools of Monetary Policy 809
The Discount Rate / Changes in Reserve
Requirements
Alternative Monetary Policies 810
The Constant Money Growth Rule 811
Implications for the Aggregate Demand/Inflation
Curve / Debates about Constant Money Growth Rules
Real GDP in the Monetary Policy Rule 812
The Gold Standard 814
Gains from Credibility 814
Interpreting Policy Actions 814
Expectations and Credible Disinflation 817
Conclusion 817
Key Points 817 / Key Terms 818 / Questions for
Review 818 / Problems 818
The Fed Chairman Speaks on Principles of
Monetary Policy 815
Chapter 31
International Finance 820
The Balance of Trade Around the World 821
The Trade Deficits 821
Both Merchandise Trade and Services Trade Are
Important 822
The U.S. Merchandise Trade Deficit / The U.S.
Services Trade Surplus
The Balance of Payments 823
The Current Account / The Capital Account
Bilateral Surpluses and Deficits 827
Sectoral Deficits 828
Exchange Rate Determination 829
Purchasing Power Parity (PPP) 829
Tradable Goods / Nontradable Goods / Explaining
Exchange Rates with PPP in Practice
The Interest Rate: A Reason for Deviations from PPP
833
Fixed Exchange Rate Systems 834
International Gold Standard 834
The Bretton Woods System 834
The European Monetary System 835
Fixed Exchange Rates and International Independence
836
Loss of International Monetary Independence 836
Interventions in the Exchange Market 837
Reducing Exchange Rate Risk 837
Conclusion 838
Key Points 839 / Key Terms 840 / Questions for
Review 840 / Problems 840
Desert Storm and the Current Account 825
Reading the News About Purchasing Power
Parity 831
Chapter 32
Macroeconomic Debates 842
Schools of Thought in Macroeconomics 844
Developments from the 1930s Through the 1960s 844
Keynesian Economics / The Monetarist School / The
Neoclassical Growth School
Developments from the 1970s Through the Present 847
New Classical Macroeconomics / The New Keynesian
School / The Real Business Cycle School / Supply Side
Economics
Macroeconomic Theory at the Turn of the Century 850
Debates about Macroeconomic Policy 851
The Bush Fiscal Package 851
Debates About the Bush Proposals
The Clinton Fiscal Package 853
Debate About the Clinton Proposals
Lessons 853
Conclusion 854
Key Points 855 / Key Terms 855 / Questions for
Review 855 / Problems 855
Chapter 33 Economic
Growth Around the World 856
Catching Up or Not? 857
Catch-up Within the United States 857
Catch-up in the Advanced Countries 857
Catch-up in the Whole World 860
Economic Development 861
Billions Still in Poverty 861
Geographical Patterns 861
Terminology of Economic Development 862
Obstacles to the Spread of Technology 862
Reduction in Restrictions in the Eighteenth and
Nineteenth Centuries 864
Remaining Restrictions in Developing Countries 865
Human Capital 866
Obstacles to Raising Capital per Worker 866
High Population Growth 866
Insufficient National Saving 867
The Lack of Foreign Investment in Developing Countries
867
Loans from International Financial Institutions /
Where Is the Saving Coming From?
Inward-Looking versus Outward-Looking Economic
Policies 870
Conclusion 872
Key Points 873 / Key Terms 873 / Questions for
Review 873 / Problems 874
Using Economics to Explain an Inadequacy of
World Saving 868
Chapter 34 Emerging
Market Economies 876
Centrally Planned Economies 877
Central Planning in the Soviet Union 878
The Five-Year Plans / Centrally Controlled
Prices
Trade Between the Soviet Union and Eastern Europe
881
Technological Change and the Quality of Goods 882
From Perestroika to the End of the Soviet Union 882
Soviet-Style Central Planning in China 883
Alternative Paths to a Market Economy 884
The Goals of Reform 884
Shock Therapy or Gradualism? 884
Economic Reform in Practice 885
Reforms in Poland 886
Reforms in China 887
Economic Freedom and Political Freedom 888
Conclusion 889
Key Points 890 / Key Terms 890 / Questions for
Review 890 / Problems 890
Karl Marx, 1818-1883 879
